The Small Business Administration Issues New Interim Final Rules on Loan Forgiveness and Loan Review: Key Points Borrowers and Lenders Should Know

On Monday, we issued an alert discussing the end of the Small Business Administration’s (SBA) amnesty period for Paycheck Protection Program (PPP) borrowers, and the release of its loan forgiveness application. Through the loan forgiveness application and instructions, the SBA created an “alternative payroll covered period” which, at the borrower’s election, begins its 8-week period on the first day of its first pay period following disbursement of the loan (as long as it pays bi-weekly or more frequently). The SBA also clarified that eligible “costs incurred and payments made” for forgiveness include both costs incurred or payments made during the borrower’s 8-week period. This applies not only to payroll costs but also to eligible non-payroll costs, with certain exceptions.

On Friday, the SBA issued two interim final rules—one on loan forgiveness and another on the SBA’s loan review procedures and related borrower and lender responsibilities. The interim final rules incorporate certain of the SBA’s previously issued responses to frequently asked questions, but also create new rules and guidance which we will examine in this alert.

I. Loan Forgiveness

Section 1106 of the CARES Act contains the loan forgiveness provisions of the PPP. A morass of different time periods, potential FTE and salary/wage reductions, and nuances throughout, Section 1106 is anything but a picture of clarity. The SBA’s interim final rule on loan forgiveness provides borrowers with additional information on certain ambiguous (or absent) provisions in the statute. Some of the new rules help borrowers to increase forgiveness amounts, while other rules will have the opposite effect.

Helpful interpretations/rules for borrowers

A. Hazard and bonus pay
Section 1102 defines “payroll costs” to include, among other things, “salary, wage, commission, or similar compensation.” That same definition applies to forgiveness requests under Section 1106. A frequent question of borrowers has been whether hazard pay or bonuses constitute payroll costs. The answer to that question is now clear—yes, an “employee’s hazard pay and bonuses are eligible for loan forgiveness because they constitute a supplement to salary or wages, and are thus a similar form of compensation.”

B. Furloughed employee pay
The SBA also determined that payments to furloughed employees will be eligible for forgiveness. If utilized, this may be helpful for borrowers that cannot get back to full staff by June 30 (the deadline for eliminating an FTE reduction), as it allows them to pay furloughed employees and count those paid hours towards the borrower’s FTE average, thereby potentially avoiding, or at least reducing, a required loan forgiveness reduction.

C. Personal property leases
While the statute is clear that interest in connection with a mortgage on real or personal property is eligible for forgiveness (as long as the mortgage was in place prior to February 15, 2020), it was less clear whether leases on personal property constituted a “covered rent obligation.” The SBA’s interim final rule makes clear that rent in connection with personal property leases in force prior to February 15, 2020 are eligible for forgiveness.

D. No double reduction for FTE and salary/wage cuts
Section 1106 requires a borrower to perform two separate calculations to determine if a reduction must apply to their calculated forgiveness amount. The first calculation requires an examination of average FTE employees during the 8-week period of the loan as compared to average FTE employees during a prior period (for non-seasonal employers, either February 15, 2019 to June 30, 2019 or January 1, 2020 to February 29, 2020). If average FTE is lower during the 8-week period than the comparison period, the borrower’s forgiveness amount will be reduced (with certain exceptions).

The second calculation requires an examination of whether certain employees experienced reductions in “total salary and wages” of greater than 25 percent when comparing that employee’s salary and wages during the 8-week period to a reference period of January 1, 2020 to March 31, 2020. The language “total salary and wages” caused much confusion, as it suggested that this calculation would be based not on an average, but on a total amount. Using a comparison period of different lengths—first quarter of 2020 as compared to an 8-week period—would serve to create a reduction even for employees that maintained current pay levels. In addition, employees that were rehired during the 8-week period would naturally make less in total (even using a weekly average calculation) because they would not receive pay for all weeks in the 8-week period. And finally, employees whose hours were cut (and therefore received less total salary/wages) could result in a double reduction—both because of the FTE reduction and the total salary/wage reduction.

The SBA’s interim final rule on loan forgiveness solves these issues. First, the SBA has made clear that the salary/wage reduction will look at the average amount of pay per week during the 8-week period as compared to the average amount of pay per week during the reference period. For example, if a borrower made $1000 per week during the reference period and $700 per week during the 8-week period, the borrower must reduce its forgiveness amount by $400 ($50 over the 25 percent grace amount multiplied by 8 weeks).

Next, and importantly, the SBA decided that borrowers would not be penalized twice for FTE and salary/wage reductions. If an employee’s hours are cut, that may impact a borrower’s average FTE calculation, but the accompanying reduction in salary/wages will not be applied to further reduce a borrower’s forgiveness amount.

E. Offers to rehire
On May 3, through FAQ 40, the SBA explained that a borrower’s FTE average would not be negatively affected if it made a written offer to rehire an employee for the same salary/wages and hours, that employee rejected the offer, and its rejection was documented by the borrower. The SBA’s interim final rule on loan forgiveness largely adopts FAQ 40, with two additional nuances. First, while the SBA could have been clearer on this point, it appears that employees eliminated prior to February 15, 2020 (the start of the statutory FTE reduction safe harbor period), could also count towards this exception if offered rehire and they refused. Second, the interim final rule imposes an additional requirement on borrowers not found in FAQ 40, namely that the borrower must inform the applicable state unemployment insurance office within 30 days of the employee’s rejection. The SBA states that more guidance will be provided on its website of how borrowers must fulfill this reporting obligation.

F. Fired for cause, resignations, and requested reductions
The SBA has provided an exception to a borrower’s FTE calculation for employees who were fired for cause, voluntarily resigned, or voluntarily requested a schedule reduction during the borrower’s 8-week period. The borrower must, however, maintain documentation to establish that the reductions were caused by these events.

Unhelpful interpretations/rules for borrowers

G. The 25 percent rule
On April 15, the SBA issued an interim final rule providing a new limitation on loan forgiveness, one not found within the statute. The SBA determined that not more than 25 percent of the loan forgiveness amount may be attributed to non-payroll costs. While the borrower’s loan amount is determined by payroll costs, Congress allowed the loan proceeds to be utilized for certain additional forgivable expenses related to mortgage interest, rent, and utilities. And Congress placed no limitation on how much of the loan could be used for these expenses.

The SBA’s rule imposed a new requirement, and one that significantly impacts businesses with higher non-payroll expenses. While legislation currently being considered may eliminate this requirement, the SBA and Treasury are doubling down. On Thursday, Treasury Secretary Mnuchin said that he was opposed to doing away with the rule, noting that the program is not called the Overhead Protection Program. Friday’s interim final rule restates the requirement, making it clear that legislative action will be necessary to remedy this issue.

H. Exception to FTE or salary/wage eliminations
As discussed above, borrowers must apply reductions to their amount of eligible forgiveness for certain FTE and salary/wage cuts. The statute, however, provides a potentially helpful exception for FTE and salary/wage cuts that are “eliminated” by June 30. But it appears, at least for the FTE reduction, that it must be restored in whole ny June 30 for the exception to apply. In other words, if a borrower’s average FTE has been restored to 90 percent by June 30, a borrower would not necessarily be permitted to utilize 90 percent for its forgiveness amount, but would be required to determine the average FTE during its 8-week period and compare that to the reference period (which will result in a percentage less than 90 if employees were hired back during the 8-week period).

I. FTE calculation
The statute does not specify how many hours an employee must work to be considered a full-time equivalent employee. Under the Affordable Care Act, for example, the Internal Revenue Service considers a full-time employee as an employee that works an average of at least 30 hours per week, or 130 hours per month. In Friday’s interim final rule, however, the SBA adopted a standard of 40 hours per week. In addition, it determined that FTEs (as well as salary/wage reductions) would be calculated on an employee-by-employee basis, rather than in the aggregate, and it capped an employee’s FTE at 1.0.

This will result in less loan forgiveness than, in my view, Congress intended. As an example, if a borrower has two employees and during the 8-week period one works an average of 50 hours per week and the other works an average of 30 hours per week, that will not count as 2 FTEs. Rather, it will only count as 1.75 FTEs. If both employees worked at least 40 hours per week during the reference period, the borrower would be required to multiply its eligible forgiveness expenses by 87.5 percent (1.75 FTE / 2 FTE), thereby reducing its loan forgiveness amount.

J. Advance payments on mortgage interest
While non-payroll expenses may include mortgage interest, the SBA clarified that any advance payments on mortgage interest are not eligible for loan forgiveness. Since the statute does not permit mortgage “prepayments,” the SBA found that allowing advance payments on mortgage interest would not be consistent with this prohibition.

II. Loan Review Procedures and Related Borrower and Lender Responsibilities

On Friday, the SBA also issued an interim final rule detailing certain of its review procedures, and expounding on borrower and lender responsibilities during the review process.

A. Time periods and review process

Bank’s review and obligations
The SBA reminded borrowers that, at any point, it may “conduct investigations to determine whether a recipient or participant in any assistance under a 7(a) program, including the PPP, is ineligible for a loan, or has violated section 7(a), or any rule, regulation or order issued thereunder.”

In most cases, however, the time frames for review will be as follows. The lender will have 60 days to review a borrower’s loan forgiveness submission and issue its decision. The lender may approve (in whole or in part), deny, or (if directed by SBA) deny without prejudice pending an SBA review.

During this 60-day period, the lender is required to confirm receipt of borrower certifications, documentation, and perform certain calculations. Notably, while Section 1106 of the CARES Act contains a provision for lenders entitled “Hold Harmless” and only requires lenders to confirm that necessary documents and certifications are received from the borrower, the new interim rule imposes significantly increased responsibilities on lenders. Banks will now be expected to review the underlying documentation submitted with the borrower’s loan forgiveness request and to verify several calculations. In addition, according to the SBA, “if payroll costs are not documented with [recognized third-party payroll] sources, more extensive review of calculations and data would be appropriate.”

Banks will likely view the SBA’s interim final rule as an unexpected and unwelcomed increase of their obligations under the PPP. Moreover, according to the interim final rule, if a borrower is found to have been ineligible for a PPP loan, the bank will lose its processing fee. Banks should be prepared to address the compliance risks that stem from this rule, since it aligns a borrower’s interest in qualifying with that of bank personnel and increases the risk of fraud occurring in the loan forgiveness process. While the statute limits a bank’s liability in certain respects, if bankers are complicit in the submission of false information to the SBA, the bank may be held liable under the False Claims Act or the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 (FIRREA).

SBA’s review
Following the lender’s loan forgiveness decision, the SBA has 90 days to review the loan and remit, where appropriate, an amount equal to the amount of forgiveness requested, plus any accrued interest. The SBA may review a PPP loan of any size. While it has not, and likely will not, release information describing how it will determine which loans less than $2,000,000 to review, many will be reviewed in some fashion. In addition, every loan greater than $2,000,000 will, according to the SBA, be reviewed during this 90-day period.

According to the interim final rule, the SBA’s review may analyze three primary considerations: 1) borrower eligibility; 2) loan amounts and use of proceeds; and 3) loan forgiveness amounts. The SBA may review whether the borrower qualified for the loan based on “the rules and guidance available at the time of the borrower’s PPP loan application, and the terms of the borrower’s loan application.” This will likely include an analysis of size qualification, affiliate determinations, and, for loans greater than $2 million, the need-based certification made by the borrower. The SBA may also review if the borrower calculated its loan amount correctly and if the borrower’s use of the loan proceeds was permissible. Finally, the SBA may review whether, and how much, loan forgiveness a borrower will receive. For this, the SBA will likely analyze the borrower’s documentation supporting payroll expenses and determine if the borrower has correctly applied all necessary reductions based on FTE averages and salary/wage cuts. It will also likely review whether expenses are incurred or paid during the 8-week period, and whether the 25 percent cap on non-payroll expenses has been applied.

While the SBA, through its Office of Capital Access and other personnel, will conduct its reviews within 90 days, the SBA Office of Inspector General, which received $25,000,000 of additional funding under the CARES Act to be used through September 30, 2024, will continue investigations for years to come. Indeed, the SBA notes in its interim rule from Friday that “the borrower must retain PPP documentation in its files for six years after the date the loan is forgiven or repaid in full, and permit authorized representatives of SBA, including representatives of its Office of Inspector General, to access such files upon request.”

Borrowers’ rights

If documentation submitted by a borrower indicates that it may be ineligible for a PPP loan, or may be ineligible to receive the full amount of loan forgiveness requested, the SBA will contact the borrower, or require the lender to contact the borrower in writing, to request additional information. The SBA will consider all information submitted by the borrower. Thus, borrowers should consult with counsel during this process, and advocate for their rights under the statute, accompanying rules, and other guidance.

In addition, upon a final determination by the SBA that a borrower is ineligible for a PPP loan, or for the full amount of forgiveness requested, the borrower will have an opportunity to appeal that decision. The SBA will issue a separate interim final rule addressing the appeal process.

B. Risks to borrowers
As we have seen through the numerous criminal actions already brought by the Department of Justice (DOJ) against borrowers, there is significant risk under this program. False certifications made by borrowers in either their loan application or their forgiveness application may be used by the DOJ to pursue convictions under a variety of criminal laws or to seek monetary recoveries under the False Claims Act. Likewise, whistleblowers (known as relators), may bring actions under the False Claims Act and are entitled to a share between 15 percent to 30 percent of any recovery.

The risk of a False Claims Act case is especially pronounced under the PPP because such cases can be proven through a showing of “reckless disregard” by a borrower. In addition, the False Claims Act damages and penalties provisions are hefty, providing for up to treble damages (three times actual damages), plus penalties of between $11,665 and $23,330 per violation. As a result, borrowers should take care to ensure that forgiveness applications are supported with documentation and are accurately submitted.

III. Conclusion
Here at Potomac Law Group, we are tracking PPP developments on a daily basis and will be updating clients as new developments and guidance comes out. If you are interested in an arrangement for your specific PPP loan to help maximize potential forgiveness and minimize risk, please reach out to dadams@potomaclaw.com or review package offerings here to learn more.